Putting the Signals Approach to Work

The signals approach described above was first used to analyze the performance of macroeconomic and financial indicators around ''twin crises'' (i.e., the joint occurrences of currency and banking crises) in Kamin-sky and Reinhart (1999). We focus on a sample of 25 countries over 1970 to 1995. The out-of-sample performance of the signals approach will be assessed using data for January 1996 through December 1997. These are the countries in our sample:

■ Africa: South Africa

■ Asia: Indonesia, Malaysia, the Philippines, South Korea, Thailand

■ Europe and the Middle East: Czech Republic, Denmark, Egypt, Finland, Greece, Israel, Norway, Spain, Sweden, Turkey

■ Latin America: Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, Peru, Uruguay, Venezuela

The basic premise of the signals approach is that the economy behaves differently on the eve of financial crises and that this aberrant behavior has a recurrent systematic pattern. This ''anomalous'' pattern, in turn, is manifested in the evolution of a broad array of economic and financial indicators. The empirical evidence provides ample support for this prem

18 ASSESSING FINANCIAL VULNERABILITY

ise.16 To implement the signals approach, we need to clarify a minimum number of two key concepts which will be used throughout the analysis.

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